A massive amount of unconventional oil is locked up in Russia’s territory, some resources dirtier and more challenging to extract and process than others. How this oil wealth is developed—from resource selection to environmental controls—will impact Russia and the world.Unfortunately, current Russian oil policies provide higher subsidies for and impose lower taxes on the most difficult-to-extract oils and the dirtiest fuels. Those policies are steering the nation in precisely the wrong direction. Flooding the market in this way with the most damaging oil resources could tip the carbon scales toward climate overload. If Russia were to instead rank its oils, subsidize development of less carbon-intensive fuels, and promote economy-wide energy efficiency, it would be on the road to providing higher-quality commodities to its primary customers in the EU and Asia and to becoming a leader in more sustainable oil development.
The history of Russian oil has been shaped by unlikely personalities, seemingly insurmountable setbacks, and improbable triumphs. Today, the Russian oil industry—Rosneft, Gazprom, Lukoil, and others—rivals the major global oil companies, including ExxonMobil, BP, and Shell in resource holdings and profitability. They are the crown jewels of Putin’s Russia: bringing in billions in state revenue, serving as the lifeblood of Siberian company towns, and standing at the helm of the Kremlin modernization effort.
Throughout the czarist, Soviet, and now modern periods, there have been sensational booms and catastrophic busts. Since 1960, Russian production of conventional crude oil has fluctuated markedly (see figure 1).
At its peak in 1987, Soviet oil output stood at a world high of 11.4 million barrels a day. In the aftermath of the Soviet Union’s collapse, oil production dwindled to a low of 6 million barrels a day in 1996. With plummeting production stemming from the widespread economic disarray of the 1990s compounded by falling international oil prices, major Russian oil companies—Rosneft, Lukoil, TNK-BP, Surgutneftegas—had little incentive for oil exploration. As a result, most of the current operational Russian oil fields were discovered before 1970 in Western Siberia.
At the start of the new century, the industry rebounded. Production was increased simply by restoring existing capacity to levels near their Soviet-era peaks. Over the past decade, Russian oil production has continued to migrate upward.
Today, Russia vies with Saudi Arabia for the title of world’s largest oil producer. But Russia’s current proven reserves do not contain nearly as much oil as Saudi Arabia’s or even North America’s. Moreover, unlike Saudi Arabia, Russia is producing oil full bore without spare capacity. As such, many perceive the Russian oil sector to be, once again, on the precipice of a major decline. Production costs are increasing, and production volumes from Soviet-era conventional oil plays (also known as brown fields) is stagnating.
Russia also has an array of untapped resources, including oils in remote new green fields that contain plentiful reserves but are expensive to develop and distant from existing infrastructure. The former Soviet Union took great interest in developing early-generation technologies to produce these oils, going as far as to fracture shale rocks using underground nuclear blasts in the Timan-Pechora Basin in the 1960s. Geologists identified these difficult-to-recover unconventional oils but left them in the ground for future generations to manage. And that is the challenge Russia now faces.
The world is gradually running out of conventional, relatively easy-to-access crude oil. Because of that, Russia, along with other states, has been operating under the assumption that its remaining oil reserves are destined to become increasingly more carbon intensive in the future. Such heavy oils have fundamentally different physical and chemical compositions and are, therefore, more difficult to handle and more damaging to the environment than conventional crude. But new developments worldwide are identifying less heavy (and often quite light) tight oil plays that are more conventional in their makeups but unconventional in their production.
Russia needs to take stock of the opportunities and challenges of its growing supplies of heterogeneous oils in order to decide its new priorities. (See figure 2 for a map of Russia’s oil reserves.) In 2000, Russia’s oil balance was 83 percent light sweet crude, 15 percent heavy oil, and 2 percent extra-heavy bitumen—an ancient oil that has been degraded by bacteria, leaving it solid like tar. By 2020, Russia’s oil shares are projected to shift. Heavy oil will double to 30 percent, bitumen will swell to 20 percent, and the result will be equal shares of light and heavy oils.
This forecast, however, does not fully consider the prospects for Russia’s tight oils, which are found in rock formations of relatively low porosity and permeability. Like the recent light-tight-oil boom in North America made possible by hydraulic fracturing and horizontal drilling, Russia stands to unlock a new class of previously unattainable tight oils.
They serve as an alternative to the even-riskier Arctic oil gambit, which poses a myriad of operating challenges, such as unpredictable weather conditions that could heighten operational risks and confound spill responses. At the same time, tight oils are less carbon intensive and damaging than bitumen.
Arctic developments have taken center stage recently as the “fourth generation of Russian oils,” but tapping into tight oils might provide the opportunity for Russia to maintain current levels of production. In 2010, the Russian Ministry of Energy’s “Energy Strategy for Russia 2030” projected at least 40 million metric tons of oil coming from tight shale plays, out of 500–530 million metric tons of annual production.1 This small share of current production does not convey the true potential of Russian tight oils, given the large volume of oil in place.
Russia has several known tight-oil formations in Western Siberia. The well-known Bazhenov Formation, with current estimates as high as 140 billion metric tons of oil in place, is believed to be even larger than North America’s Bakken Formation. Located in North Dakota, the Bakken contains one of the largest known plays of light-tight oil with as much as an estimated 70 billion metric tons of tight oil in place. Tight oil is also found in the Abalakskaya and Frolovskaya Formations in Western Siberia. While not all of this oil in place is technically recoverable, it still represents a vast new resource potential.
Within the class of tight oils, however, there is significant variation, and these resources may be somewhat different than their North American counterparts. They appear to be not quite as light, to require more energy to extract, and to be even more remote than those in the United States. Despite frequent comparisons, the upper Bazhenov in particular contains tight oil that is more viscous and resistant to flow than the ultralight U.S. tight oil formations. Still, Russia’s tight oil is in the sweet spot to replace dwindling light crudes.2
Russia also possesses significant bitumen resources, estimated at 35 billion metric tons, with an additional estimated 29 billion metric tons deposited in remote parts of Eastern Siberia. Tatarstan alone may have 7 billion metric tons of bitumen. But these plays are very deep—up to 1,000 meters (3,280 feet). They cannot be accessed by mining and require massive volumes of steam injected deep underground to heat and liquefy the bitumen. This necessitates large inputs of water and natural gas.
Despite their geologic challenges, regional bitumen plays have been under development in Tatarstan since 2006. Today Tatneft, an oil and gas company in Tatarstan, is using techniques similar to the ones pioneered in Alberta, Canada, to recover bitumen from almost 300 meters (985 feet) underground.
In addition to tight oils and bitumen, Russia is home to kerogen or oil shale, an immature oil resource that is made up of chemical compounds found in the organic matter of sedimentary rocks. There are kerogen deposits in the upper regions of the Bazhenov Formation. But kerogen is even more energy intensive, carbon concentrated, and difficult to extract and process than bitumen.
Russia has numerous new oils to choose from, each with resource characteristics and extraction challenges that differ both from one another and from the conventional crude that has dominated the industry over the past century. In attempting to access Russia’s future oil supplies, companies will be confronted with adopting new production techniques as well as new refining processes. Russia’s existing fiscal, foreign investment, and institutional arrangements cannot adequately address the changing oil landscape. Moscow will have to adapt its existing system to manage these opportunities wisely and safely.
Perhaps the biggest immediate challenge facing the Russian oil sector is the acute need to increase the share of oil rents that are invested back into the industry. Without adequate reinvestment, efficiency gains in the sector will stall, responsible practices will not be established, production declines will set in, and the sector will be forced to rely on more damaging, low-quality oils.
The tax system in Russia is also working against the development of new higher-quality oil resources. The Russian government currently taxes conventional oil at high rates, with a $55 per barrel standard export duty. The tax rates have not dissuaded Russian oil companies from spending on capital maintenance and reserve replenishment, but hefty duties can have an impact on new hydrocarbons, which require fiscal incentives (or lower disincentives) to increase production efficiency and adherence to environmental standards. To encourage extraction and production of new hydrocarbon resources, bitumen has been exempt from the tax on natural resources since 2007. The Russian government is also considering field-by-field tax breaks, with the most difficult-to-extract resources getting the biggest benefits, ranging from a complete exemption for ten years to a 50 percent tax break for five years. This is counterproductive considering that there are easier and less damaging oils available to access.
To develop these oils, the Russian government prefers large, integrated projects with major state involvement and highly capitalized companies. Rosneft has signed with ExxonMobil to develop tight oil in the United States, which will provide valuable know-how for domestic tight oil plays. ExxonMobil has also agreed to partner with Rosneft to develop Russia’s Bazhenov field. Other foreign oil companies, such as Royal Dutch Shell and Statoil, have either entered into or are considering signing agreements to jointly explore and develop Russian tight oils. And Gazprom is developing the Achimov condensate field in the Yamal-Nenets Autonomous Okrug through its sister company, Gazpromneft.
However, Russian oil companies could face challenges as they shift from producing conventional oil from large fields to managing a myriad of smaller, unconventional plays. While some small firms, like Irkutsk Oil, have made a foray into privately leased conventional oil formations in Eastern Siberia, most have not yet ventured into tight-oil production. Petroneft in Tomsk Oblast is among the first to produce tight oil.
Foreign investors—big and small—are central to this process of developing tight oils. As independent oil producers look to attract foreign capital, they will want to replicate the business models of successful Western companies that have prospered from the shale gas revolution in the United States. Russia’s business environment will need to become more hospitable to smaller, independent companies that need to navigate uncertain conditions, assume high risks, and endure small production volumes associated with tight oil plays.
Finally, institutional arrangements regarding resource ownership create barriers in Russia to new oil development. Unlike in the United States, where natural resources not located on public lands are private property, the Russian state owns all of the hydrocarbons in the ground. This creates little incentive for small firms to explore for unconventional oil since there is no guarantee they would be able to lease the territory on which oil was discovered.
The infrastructure in which Russia reinvests will profoundly affect the nation’s oil supply chain, from production to refining to product exports. Beyond raw oil inputs themselves, changes in the global demand for lighter, less carbon-intensive, cleaner petroleum products will challenge the current Russian oil establishment.
The Russian refining sector, despite being third largest in global capacity (behind the United States and China), has only recently begun to be modernized. Russian refineries currently produce a disproportionately large share of dirty, carbon-heavy fuel oils, which has nearly tripled in volume since 2000. A reason for this, beyond older infrastructure, is that Russia taxes its unprofitable refined heavy oil at a lower rate than light oil—and a much lower rate than crude—in order to support demand for low-quality petroleum products. Products could further degrade if Russia preferentially develops its bitumen and kerogen, which have very high carbon contents and favor production of a very heavy range of products compared to tight oils.
Russian refineries tend to produce low-value products. The United States, by comparison, has expensive, complex refining capabilities in which difficult feedstocks are transformed into high-value products.3 The EU, meanwhile, is talking about shuttering its refineries, which would ultimately make Russia’s closest trade partners dependent on imports of petroleum products from global refiners.
Refinery upgrades are slowly enhancing Russia’s product quality. With high demand for lower sulfur diesel fuel both in Europe and Asia, Russia needs to reduce the amount of heavy fuel oils it produces and increase the share of more valuable refined petroleum products that can meet more stringent environmental standards.
The precipitous collapse of the industrial base following the breakup of the Soviet Union has made it possible for Russia to meet even the most ambitious carbon-emissions-reduction goals with little to no effort. This has generated an attitude of complacency within the Kremlin that—along with dependence on oil rents, an energy-intensive economy, and the slow pace of energy-efficiency reforms—prevents Russia from being a leader in efforts to mitigate climate change.
Moscow cannot remain ambivalent about climate change. Global warming will both impact and be affected by oil decisionmaking in Russia. Evidence suggests that the effects of greenhouse gases are more drastic in the country’s northern latitudes, where the bulk of the current Russian oil exploration and production efforts are centered.
According to the Federal Service for Hydrometeorology and Environmental Monitoring, Russia’s average temperature is rising at twice the global average rate, with some parts of Siberia warming at three times the global rate. The melting of permafrost has already resulted in economic costs and could pose a major challenge to existing pipelines and drilling rigs, making future infrastructure projects significantly more expensive and difficult to operate safely. This is especially the case in regions such as the Yamal Peninsula, which the melting of the permafrost would turn into a marshy bog in the summers that would lack the firm foundation needed to support infrastructure and make the region less accessible to oil development.
In addition, costly Arctic drilling—estimates on the economic viability of Arctic oil range from as low as $75 dollars per barrel to well over $100 dollars—risks damaging ice sheets, releasing methane stored in permafrost, and tampering with fragile carbon sinks that are integral for the earth’s natural carbon-sequestration mechanism.
Russia has access to a variety of oils, which allows it to be selective about its unconventional oil plays. Climate change must be factored into the long-run costs of making oil investments. It behooves Russia to avoid investing in the most damaging oil resources. They could ultimately have to compete with less carbon-intensive oils in addition to future climate regulations.
High global oil prices have led to complacency about instituting reforms, improving the tax regime, and addressing climate concerns in Russia. Today Russia derives 40 percent of its federal budget from oil rents. The Russian Federation relies on oil prices to remain at or above $110 dollars per barrel to balance its federal budget. Yet with major increases in overall government spending and pressures from declining crude production in Western Siberia, Russia’s oil-rentier system is in need of a dramatic overhaul.
Russia needs to diversify from a commodity-driven economy, a reality that is not lost on the Kremlin but is incredibly difficult to achieve. And there is an immediate need to channel current investments into the most sustainable and safe new oil plays. One path forward is to prioritize Russian oil developments based on their climate impacts, subsidize the development of less carbon-intensive fuels, and promote economy-wide energy efficiency.
Russia will also likely have to reconsider development in the Arctic. Due to the extraordinary complexity of extracting oil in the Arctic, developing in this extreme environment is predicated on high, stable oil prices. Yet the U.S. Energy Information Administration forecasts that global oil prices through 2040 could fluctuate from as low as $60 dollars per barrel to as high as $250 dollars per barrel. Estimates in this time frame have global oil supplies swelling by at least 6 million barrels per day—or even twice that production rate. Although political instability in the Middle East and the uptick in global demand are making it unlikely that oil prices will collapse, the uncertainty suggests that costly forays into the Arctic should be permanently placed on hold. Similar problematic forecasts can be made for challenging extra-heavy bitumen and kerogen oil resources.
Instead, Russia should focus first on developing those oils with the lowest external costs—smallest environmental impacts and carbon footprints. Onshore tight oils may be easier to handle and less carbon intensive than Arctic resources, serving as a more cost-effective and ecologically manageable option. As such, the Russian government needs to institute incentives for tight-oil exploration, remove subsidies for dirty fuels, reinvest in high-quality fuel-refining capacity, and bolster transparent data collection to ensure that carbon footprints of these oils are minimized.
As the world grapples with the blessings and curses of a new bounty of hydrocarbons, Russia can provide global leadership by successfully navigating this new oil frontier. The prudent path for Russia is to invest in an economically and environmentally sound course for its diverse array of hydrocarbons.
1 Multiply by 7.33 to convert units of measure from metric tons oil to barrels of oil.
2 Tight oil in the Bazhenov ranges from 30°–45°API gravity compared to U.S. light to ultralight tight oils with gravities of 45°–75°.
3 The Nelson complexity index measures a refinery’s secondary conversion capacity relative to the primary distillation capacity and is an indication of how complex a nation’s refining capacity is. The higher the number on the index is, the more complex the refinery’s capabilities are. Russia has an index of 5, the United States 9.5, and the EU 6.5.
The Carnegie Russia and Eurasia Program has, since the end of the Cold War, led the field of Eurasian security, including strategic nuclear weapons and nonproliferation, development, economic and social issues, governance, and the rule of law.
The Carnegie Energy and Climate Program engages global experts working on issues relating to energy technology, environmental science, and political economy to develop practical solutions for policymakers around the world. The program aims to provide the leadership and the policy framework necessary to minimize the risks that stem from global climate change and competition for resources.
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